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Happy New Revenue Year for Tech Companies! IFRS 15 for FY18.

30 January 2018

by Gareth Murfitt, PwC Technology partner

Tech companies continue to benefit from global digitalisation, huge investment funds focussed on the sector, a growing number of entrepreneurs and some eye-watering valuations.

From 1 January 2018, the revenue recognition profile of some of these companies will change as the new accounting rules come into effect for US and IFRS (Internal Financial Reporting Standards) reporters.

While some things will remain the same, there are a number of key changes that will disconnect revenue recognition from cash collection and, arguably, make the cash-flow statement more important than ever. Some key changes are as follows:

1. SaaS is definitely King! What about a Term Licence?

SaaS revenue recognition is unchanged, recognised evenly over the service period. The predictable nature of SaaS revenue recognition, and the ease with which customers can adopt SaaS, will continue to drive success for these tech companies and result in a premium on valuation.

For more traditional term licences vendors, revenue may now be recognised upfront on delivery of the software term licence rather than spread evenly over the service period. This will see some software companies recording ‘spikes’ in revenue when deals are signed and delivered and large unbilled receivables on the balance sheet as the cash is collected over, for example, 3 or 5 years.

This change is unpopular with many companies, and investors, as it significantly increases the impact on your annual results (and valuation / share price) based on the timing of when a large deal may, or may not, get signed.

As a result, the march towards SaaS in the software industry has just got even faster.

2. Principal or Agent (Gross or Net) – more likely ‘Net’ now.

Revenue multiples are a critical feature of tech valuations, therefore, the assessment of whether certain revenue streams should be accounted for gross or net is an important one.

How are tech companies that sell 3rd party services, software and products alongside their own recording this revenue? The new revenue standard stops vendors recognising revenue gross primarily on the basis that they have the risk of cash collection. This argument is no longer fundamental and we are already seeing more tech businesses recognise revenue net (commission only) when selling 3rd party services and products.

Whilst this change is generally unpopular with tech companies, as it reduces the top line, on balance it usually presents a more accurate view of the companies’ performance for stakeholders.

3. Upfront / Set up fees must be deferred but what about cash?

Tech companies, if they can, charge ‘set up’ fees in advance of providing the service or software which may comprise data transfer and basic installation. Under the new revenue standard, these set up fees will often be deferred and recognised once the service/software goes live. While not typically a large proportion of revenue, this change may make it harder for growing tech companies to get cash from customers earlier in the relationship. The risk here being that the vendors will need to finance the set up work themselves so must be equipped to do so.

In the short term, the new revenue standard will of course impact how companies recognise revenue. But, as we've indicated here, it could very rapidly change how they do business too.